The CMG Plan: Your Mortgage as a Checking Account

1 August 2005, Rewritten November 28, 2007, Revised January 7, 2008, August 28, 2011

HOA is a permanent mortgage that has some features found only in a demand deposit account at a bank, and other features similar to those in a home equity line of credit (HELOC), except better.

HOA as a Deposit Account

An HOA can be used as if it was a checking account. A borrower’s paycheck, instead of being deposited in a bank account to earn little or no interest, pays down the mortgage balance. The borrower thus earns the mortgage rate starting the day of deposit.

As the borrower spends money, by writing checks, withdrawing cash from an ATM, or using a bill-pay service, the mortgage balance rises. Even if the balance at the end of the month is the same as at the beginning, the average balance – and therefore the interest charge -- is lower.

HOA As a Line of Credit

Both HOA and a home equity line of credit (HELOC) accrue interest daily, and adjust the interest rate frequently -- monthly on the HOA, anytime on the HELOC. Borrowers can draw up to a specified maximum amount at any point during an initial 10-year draw period, with repayment required over the ensuing 20 years.

But there are important differences. HOA is a first lien and is used to purchase properties and to refinance existing loans. A HELOC is usually a second lien and is used for other purposes, such as home improvements and consolidating other debts. A HELOC cannot be used as a deposit.

Perhaps the most important difference is that an HOA borrower has no required payment, and can even withdraw funds during the repayment period, so long as the current balance is below the maximum balance. A HELOC borrower must make a payment every month and cannot make withdrawals during the repayment period.

The HOA maximum is unchanged during the first 10 years, unless the borrower exercises a one-time option to increase it. During the 20-year repayment period, the maximum balance declines every month by 1/240 of the amount at the beginning of the repayment period.

The interest rate risk is also much lower on the HOA. The maximum HOA rate is 5% over the initial rate, whereas HELOCs have no contractual maximums; they are limited only by state usury ceilings, which range from 18% to 24%.

HOA as a Permanent Mortgage

HOA is an adjustable rate mortgage (ARM) with monthly rate adjustments. Monthly adjustments make the HOA more sensitive to market changes in both directions than hybrid ARMs on which the initial rate is fixed for 2 to 10 years.

Terms Before the Financial Crisis: The HOA rate is fully-indexed, meaning that it equals the current value of the rate index plus the margin, starting in month 1. Before the financial crisis, the margin was 2.25%, which was a common margin on prime hybrid ARMs. The index was about 5% in October, 2007 making the HOA start rate about 7.25%. This was well above the start rate on hybrid ARMs.

However, HOA borrowers could get 90% loans (10% down) without paying for mortgage insurance. Further, for 2.75 points, borrowers could buy down the margin from 2.25% to 0.75%, which would reduce the start rate to 5.75%. For borrowers who
bought down the margin and took a 90% loan, the cost of an HOA was not much different from other ARMs that did not offer the same advantages.

Terms After the Financial Crisis:  In August 2011, the lowest margin available was 2.85% at 1.25 points. Because the index was about 0.2%, the fully indexed rate was 3.05%, but a floor rate of 3.5% made that the initial rate. At that time, a 5/1 hybrid ARM was available with a margin of 2.25% and an index of 0.8%, resulting in a fully indexed rate of 3.05%, same as on the HOA. However, the rate for the first 5 years was 2.625%, whereas the HOA rate was 3.50% and it could go higher within the 5 years. The HOA pricing had become disadvantageous relative to hybrid ARMs.

HOA as an Early Payoff Tool:

HOA is over-hyped as an early payoff tool, because the prospect of paying off early captures people’s attention. However, while the intra-monthly interest savings described earlier are real, they don’t add up to much.* To pay off a 30-year loan in 10 or 15 years requires extra payments, and you don’t need HOA to make extra payments. The flexibility of the HOA, however, makes it easier.

HOA As a Flexible Planning Tool

Flexibility is the major virtue of the HOA. Borrowers with money that they might use to pay down the mortgage, but don’t because they might need it again, don’t have to make that choice. They can use it, and if they need it again, they can draw it out. Borrowers with highly unstable incomes can make a large payment when they are flush, and skip making payments when they are not.

In September, 2004, I wrote an article called How Would a Truly Flexible Mortgage Work? In that article, I stated "Borrowers need a flexible payment mortgage that would allow them to accumulate a reserve within the mortgage by paying extra when they have extra funds, allowing them to skip or reduce payments when necessary." I didn't realize at the time that the HOA did exactly that.

HOA is a mortgage for responsible adults. You need a FICO score of at least 680, you need not escrow taxes and insurance, and you must put 10% down.

*Note: The statement that the intra-monthly savings don't amount to much applies to the typical borrower who deposits a paycheck and uses it up over the course of the month. If a borrower has a business that generates substantial cash flow, running the cash through the HOA account could generate larger interest savings. 

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